Strong bounce in risk assets could continue

But market vulnerable to negative shocks

The ICE BofA US High Yield Index returned 0.0% following a decline of as much as 2.6% early in April. The recovery in credit was uneven; the breadth of the rebound was narrower than the decline as investors crowded into fewer positions that were perceived to be safe, at least for now.

With spreads hitting 309 basis points (bp) on May 13, rallying 152bp from recent highs and well below the 10-year average, we believe that generic credit spreads, along with risk assets broadly, are pricing in a very low probability of a U.S. recession this year. It is remarkable to us that high-yield spreads have rallied to within 8bp of the lowest value during the 2008-2023 period. Spreads are both a coincident indicator of financial conditions as well as a forward indicator of expected losses from defaults. With a negative Q1 GDP print in the U.S. and headwinds for many cyclical businesses, we believe that the odds of a recession are significantly higher than market pricing indicates today.

With high yield spreads in the low 300s, any additional spread compression will likely be a slow grind from here. Valuations are now once again at levels that leave the market especially vulnerable to negative shocks. While the market has concluded for now that the increased tariff regime under Trump will not cause significant economic pain, we believe more time is needed to see the impact of the changes, the terms of which are both material and constantly changing.

According to Bloomberg, as of May 13, post the dramatic rollback of China tariffs, the effective U.S. tariff rate is now around 13%, dramatically higher than the effective rate on March 31, which was itself a spike from the status quo coming into 2025. This is effectively a tax paid by companies and consumers and a headwind for economic growth in 2025.

While equity markets are higher and credit spreads are tighter than they were before “Liberation Day,” the event itself could have lasting implications for both the economy and markets. Container shipments from China to the United States fell in April and will take weeks to recover, reducing sales and profits for affected industries. The U.S. Treasury market saw a dramatic selloff in mid-April, some of which was likely driven by foreign investors seeking to reduce their U.S. exposure. With the U.S. Treasury running large fiscal deficits, reduced demand for their issues from foreign buyers has the potential to impact risk premiums.

We suspect that the U.K. and China provisional deals represent both a floor and a ceiling for tariff rates on inbound goods to the U.S. going forward. China achieved a better rate than the initial April 2 announcement while the U.K. did not. The better outcome for the country that fought back hard will likely encourage trading partners to hold firm in negotiations and use leverage where available.

The strong bounce in risk assets could continue in the coming weeks. But post the China deal, valuations appear elevated. Changing global trade dynamics could have unexpected consequences. There is potential for Treasury markets to create risk-asset volatility sooner than later with the curve close to the point where markets have historically become concerned about funding costs.

Justin Jacobsen, CFA, is the Portfolio Manager of the Pender Alternative Absolute Return Fund at PenderFund Capital Management. Excerpted from the Pender Alternative Absolute Return Fund Manager’s Commentary, April 2025. Used with permission.

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